PLUS Loans: Limitless Funding Threatens and Deludes Families
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UPDATED: Nov 11, 2013
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Private student loans are vilified. Subprime mortgage loans are slowly being eradicated. But there is another loan product readily available to borrowers that could do even more damage: PLUS loans.
As a part of the student funding program offered by the Department of Education, PLUS loans fill in the large gaps left by limited federal options like Perkins Loans and federal grants.
In August of this year, President Obama passed a law decreasing the interest rate on federal student loans. Although a lower rate of 6.41 percent helped to reduce interest charges for PLUS loans, large problems, such as non-existent loan limits and lax underwriting, were left unchanged.
Loans.org investigated how this oversight can cause sweeping problems for both borrowers and their families.
Patrick Kandianis, co-founder of SimpleTuition, said that part of the limited lending rules comes from legacy issues. Originally, the PLUS loan program was viewed as supplemental to other aid and not borrowed in large amounts. As the cost of college increased, these norms disappeared.
“More parents turned to these loans and private education loans because the delta between costs and student financing levels grew,” Kandianis said. “More people were gaining access to loosely credentialed credit.”
Parents and graduate students can utilize PLUS loans and borrow the remaining cost of college if necessary. This can stretch into tens of thousands of dollars per year.
The problems do not stop there. Not only are parents able to borrower limitless amounts of student loans for their children, they qualify even when they have no means to repay the debt. The Parents PLUS loan program, coupled with the Grad PLUS loan program which works in a similar fashion for graduate students, only runs a simple credit report to see if a delinquency has occurred in the past 90 days, if the borrower has a tax lien against them, or if they have faced a recent repossession or bankruptcy.
It does not require a detailed employment or asset account and it does not require borrowers or co-signers to detail how they will pay off the student loans. The lack of rules creates an unstable environment for both the borrowers and the federal government — a situation akin to what we saw during the recent mortgage crisis.
Increased Capital But Added Risk
This high level of risk is simply a part of the PLUS loan program, according to Navah Fuchs, chief education officer for Angel Ed.
She said if underwriters denied the federal loans based on the risky nature of the borrowers, it would be counterintuitive to the specific loan purpose.
“All federal student loans operate on the premise of making capital available to those who otherwise would not be able to afford their educational pursuits,” she said.
The need for funding is evident, but the limitless borrowing power is problematic. Fuchs said the loans are “unfortunately structured.”
Despite a generally lax underwriting policy, each borrower’s experience is different. For 26-year-old college graduate Daniella DiMartino, the loan process for her father was extremely long-winded when he applied in late 2010.
For the $13,000 that DiMartino’s father borrowed on her behalf, he was required to provide information about employment, taxes, pensions, savings and other financial documents proving that he was fit to repay.
He was hesitant to take out the loan for her due to low post-grad employment rates. He also knew that he was legally liable for all of the debt. Even two years later, after securing an account executive position with a public relations firm and faithfully paying her monthly dues, her father remains concerned. She understands why. Each time her father needs to prove his financial history, such as when buying a car or applying for a credit card, the student loan debt is present.
“When he goes to look for anything, it is there,” she said.
It is commonly thought that borrowing from federal lenders is safer than from private lenders, but the government’s overarching power of retrieving loans makes it nearly impossible for borrowers to hide from their debts. Borrowers can lose significant amounts of their wages, Social Security checks, and tax returns if they do not repay the federal loans on time.
In comparison to credit card companies who have retrieval rates in the single digits, federal student lenders have a phenomenal recovery rate, according to Mark Kantrowitz, senior vice president and publisher of Edvisors.com. The federal government nets between 80 to 85 percent of the money it lends, while the gross rate, before paying collection agencies, is over 100 percent.
DiMartino and her father can count themselves among the lucky who have not faced the brazen retrieval methods of the government. But as the PLUS loan program grows, so will those affected by it.
In 2011, the government approved $10.6 billion in Parent PLUS loans to fewer than one million borrowers. For PLUS loans originating in the 2011 fiscal year, it expects about 9.4 percent will default in the next 20 years. This figure is only for budgetary purposes because the real default figure will likely be higher.
Even on a shorter time period, federal student loan default rates are higher. The DOE found that 14.7 percent of federal student loans defaulted during a three-year time period.
This increasing rate has caused many private lenders, such as Sallie Mae and JP Morgan, to limit or stop their student loan programs.
As the options for borrowers diminish, it is likely that the large PLUS loan figure will increase.
Chasing Dreams Regardless of the Cost
Although it complicated the borrowing process, DiMartino was lucky that the federal government required financial documents from her father.
Kantrowitz said the DOE should create more rational loan limits. He said students are borrowing loans based on how much the college is charging and not how much they can realistically repay.
More debt-to-income ratios and financial documents should be required to borrow. Kantrowitz said that before the loan is approved, the government should question: “Is this parent presently able to repay this debt?”
A common lending rule states that borrowers should not take on more debt throughout their education than they can earn during one year post graduation. So if a future social worker faces an average income of $35,000, this borrower should not request more than that figure, whereas lawyer that will likely earn over $100,000 can increase the debt limitations for his or her education.
Advisers recommend these equations, but they are not followed by either lenders or borrowers.
“It’s not really well designed to give signals to what is a reasonable amount of debt,” Kantrowitz said.
Instead, he said borrowers are “chasing a dream” regardless of the long-term cost.
To determine the value and borrowing standards of higher education, surveys must be collected. Data such as a specific institution’s deferments and default rates could be organized, but it is not. Kantrowitz said the federal government legally has to collect and assess certain items each year, but providing above and beyond is avoided.
Unless the data is requested from Congress, the government will not begin analyzing it. He has personally requested financial data from the DOE and been turned away.
Kantrowitz said there is a “distinct lack of awareness of the nature of the problem” facing borrowers and their families because this data is absent.
Time and time again, experts promote a simple suggestion that could have a sweeping impact on the debt issue: education. If borrowers are educated about how student loans work, how much will be repaid over the course of a loan, and how default could impact their future life, borrowers would treat the lending process more seriously thereby improving the student loan system.
Without necessary data like university-specific default rates, financial education is much more difficult. Furthermore, without this information, Kantrowitz said it is impossible to make claims about the value of an education.
“How can you say that debt makes college more affordable?” he questioned.
Fuchs does not denounce the importance of a college education, but she does question the amount of money invested in various outlets. Most universities, whether prestigious or not, devote thousands to millions of dollars per year on positive public relations, such as landing on eco-friendly lists.
This same dedication is not transmitted to more beneficial outlets, such as job placement and career counseling sessions for students.
“Right now, you’re basically buying the degree rather than earning it,” she said.
Startup Of Oneself
Student loan debt has been labeled as another potential economic crisis, similar to the housing crash that plagued the United States in 2008 and subsequent years.
Whether or not student loans have the power to deface a country’s economy is uncertain. If the loans do have that power, there is simply not enough protection or limitation for borrowers.
To prevent another housing crisis, the Consumer Financial Protection Bureau has created and passed several mortgage lending rules which make subprime lending nearly impossible. Although the CFPB has created an educational platform for student borrowers, rules governing educational funding is significantly less impactful.
Kandianis said this is because the CFPB is charged at overseeing private, bank-driven lenders even though federal lenders originate about 85 percent of student loans.
The Bureau is a significant force in consumer lending. But students do not need studies about debt, they need laws for protection.
“Someone should be watching,” Kandianis said. “Expanding the CFPB to cover it could be the answer.”
Fuchs believes the solution lies more within the context of how students view themselves and their value in the working economy. She said student loans should be under the same regulation as businesses. Almost all startups are denied standard business loans because the risk of failure is too high. Once the business proves itself, the possibility of funding is expanded.
In this way, only the most dedicated businesses, and the owners with the most realistic ideas about their need within a community or economic sector, survive. This same idea could transfer to students in a positive way.
College students across the country have deluded ideals about their economic value. This is repeated semester after semester. For example, it is present for the philosophy graduate who leaves higher education with $80,000 in debt but is facing job offers of $30,000 per year.
Each student can make a meaningful impact on society, but not every student has the potential to make six figures per year.
If lenders were willing to view students in the same light as startups, writing a check to the borrower and expecting interest back, the process should be the same. Fuchs said that going to college is the same thing and students should gain the resources and knowledge to become a marketable entity. In the end, college is a startup of oneself.
“If you can’t hold the same accountability, the same regulations, as the entrepreneur, you are doing a disservice to that student,” Fuchs said.